Monday, December 19, 2005

Oil at a record high?

One of the dumb stories of the year, one heard in constant refrain, has been the "oil prices are at a record high" story. But it's just not true. Who would have thought: journalists looking for an easy story and politicians looking for a scare, and neither of them interested in the facts.

The graph above from July 2005 shows the story: oil prices since 1970 (shown in constant July 2005 dollars). Have prices in 2005 been high? Yes. Have there been good economic and geo-political reasons for the price rises? Why, yes there has been: refinery problems and a war in Iraq reducing supply; and a rising standard of living in Brazil, Russia, India and China (BRIC) increasing demand. (Excessive taxes on production and exploration might not be considered 'good' reasons, but they do play a significant role in keeping prices high.) But the total supply of oil has still increased in recent years, even as scaremongers and Jeanette Fitzsimons tell you otherwise.

Supply increases because of human ingenuity. Proved world reserves of oil, which were 762 billion barrels in 1984, are now estimated at 1,189 billion barrels. As for the growth of demand, which normally follows population and revenue growth, [economist Julian] Simon argued that it would be dampened by new technologies that reduce the use of oil (like lighter cars), and eventually by new materials. The value of petroleum as a proportion of finished products will continue to decrease. And contrary to Malthusian fears, population growth will spur the potential for inventions.

As long as politicians and other meddlers keep out of the way of the entrepreneurs and innovators, higher prices when they exist will be a spur to increased production and the introduction of new and alternative technologies. Political meddling will only hinder any transformation that needs to happen.